Risk Management in
Islamic Financial Instruments
130
risk, price exclusion, and information asymmetry (Ahmed 204). Muslims voluntary exclude
themselves from formal financial services since Islam prohibits participation in interest-based
mechanisms. In Muslim countries, 20 to 40 percent of the population chooses to eschew
conventional microfinance services that utilize interest-based instruments. Financial exclusion
results in inefficiencies and higher costs, especially for the poor. Exclusion forces people to find
other means maintaining savings, such as converting cash into jewelry or gold. However, this
results in higher transaction costs than if the cash was saved in a financial institution. In
addition, people without access to financial services expend more time and energy in
managing their money (IFSB 140).
There are four types of organizational models for providing financial services to the poor:
commercial, non-profit, mutuals or cooperatives, and community-based organizations. Non-
profits, mutuals and cooperatives, and CBOs are also driven by social motives. They are able to
reach farther and deeper into low-income communities, but struggle with financial
sustainability. Commercial firms are driven by profit. Their approach results in greater
efficiency and sustainability, but their services are not always accessible to the poorest of the
poor (Ahmed 208).
One type of financial service that focuses on pro-poor financial inclusion and has grown in
popularity over the last four decades is microfinance. Microfinance institutions provide credit
to the poor. Some also provide services for savings and risk mitigation. With the lack of
development and level of poverty in many Islamic countries, Islamic microfinance can be
leveraged to provide access to financial services to the poor in those countries. In compliance
with Shariah, Islamic microfinance provides the poor with real assets instead of cash (IFSB 5).
Islamic microfinance institutions have several Shariah-compliant financial instruments they
can utilize. Qard-al-hassan is interest free loans. To comply with the stipulation that
transactions must involve real objects, transactions can occur as partnerships (sharikat) or
exchange contracts (mu’awadat). Through sharikat, profits can be shared either by
musharakah or mudarabah. In musharakah, two or more parties contribute funds and the
profit is divided based on a pre-determined ratio. Mudarabah differs in that it involves only
two parties, and one party provides the funds, while the other party manages the funds.
Similar to musharakah, profits are divided based on a pre-determined ratio. The most popular
MFI model is the Grameen model for group-based microfinance.
The effectiveness of microfinance in reducing poverty is a polarized and debated issue, with
examples of great success and failure (Ahmed 205-206). Opponents of Islamic microfinance
argue that it is too costly. Traditional microfinance in many cases is cost inefficient, since it
cannot take advantage of economies of scale. With the additional costs from Shari’ah
compliance, Islamic microfinance becomes even more costly (Grais 12-13, IFSB 133). However,
according to Grais, Islamic microfinance has the ability to bundle several services that can help
reduce costs (Grais 13). In addition, the IFSB recommends that areas with small Islamic
microfinance industries implement regulations gradually, starting with licensing, accounting,
disclosure and governance (IFSB 133). The price-deferred sale (bay-mua’jjal) is a form of
exchange contract. In bay mua’jjal, an object is exchanged, and the recipient is allowed to pay
the price of the object at a later time. Two types of bay-mua’jjal include 1) mark-up sale